China Revalues Yuan, But It's A Long Way from Free Float

Paresh Upadhyaya, senior vice president and portfolio manager at Putnam Investments, said China seems to be following Singapore’s model, and that they will probably not reveal the weights nor the composition of the basket of currencies they will be using. “China will now have a more flexible exchange rate, but they will still maintain a degree of control over their currency,” he said.

Upadhyaya, who works with Putnam’s global currency team, believes today’s move “is the first step,” and that China will likely enact a series a small revaluations in the coming years.

Lei Wang, a co-manager of the Thornburg International Value Fund/A (TGVAX), said he expects more mutual fund flows into Asia as investors seek increased exposure to Asian assets. He also believes that Asia’s consumer-related sectors, such as retailers, airlines, banks, toll road companies, and refiners, will benefit from the yuan’s revaluation.

“This symbolic and small move may invite more speculation on further moves, which may lead to more hot money flowing into the country or region, adding more difficulties to China’s monetary policy,” Wang noted. He cautioned that “from a micro level, Chinese companies need to prepare themselves for this new currency regime.”

Dator added that he thinks the Chinese government could revalue the yuan even further, but certain issues they face, such as the financial condition of the banks and employment, would “probably prevent them from moving to a free floating currency immediately.”

On a macro level, Standard & Poor’s believes several ‘positives’ are likely to occur because of China’s plan to revalue its currency. Specifically, the revaluation is likely to trim the U.S. trade gap with China in the longer term, as the increased cost of imported goods eventually reduces demand. In the short run, however, the U.S. trade gap may actually widen, as the cost of goods will rise more rapidly than the attempt to secure less-expensive substitutes.

The revaluation is also likely to improve the competitiveness of U.S. goods against more expensive Chinese goods (if the U.S. still produces goods that are in direct competition with Chinese goods, that is). On the other hand, China may decide to reduce the cost of the exported items to offset the effect of the stronger yuan. The revaluation also reduces the threat of trade sanctions imposed by the U.S. Congress on Chinese imports, and may stem the tide of U.S. job losses overseas. It is likely to weaken the value of the U.S. dollar from a reduced need to peg the yuan to the dollar.

Standard & Poor’s also believes there are some likely ‘negatives.’ The revaluation is likely to raise the cost of Chinese imports, thus putting pressure on margins for retail and tech companies. Another possibility is that the revaluation could increase the threat of higher inflation in the United States as a result of these higher costs. Gold prices could rise in response to the possibility of higher U.S. inflation.

Below is a list of mutual funds and exchange-traded funds from Standard & Poor’s database that are focused on China/Hong Kong. While investors have flocked to China funds in recent years seeking gains from its growing economy, they can be subject to sharp losses and high volatility, evidenced by the variability of their returns. That alone would make them more suitable for investors willing to ride them out for the long term given corporate governance issues and China’s growing pains.

Contact Bob Keane with questions or comments at: [email protected].